Deficit vs Debt: How They Affect Each Other and Economy

How the Deficit Worsens the Debt Which Worsens the Deficit...

deficit vs debt
Each year's deficit adds to the debt.. Photo: Image Source/Getty Images

Definition: A budget deficit is when spending is greater than the revenue received for that year. That's known as deficit spending. The national debt is the accumulation of each year's deficit. When revenue exceeds spending, that creates a budget surplus. A surplus subtracts from the deficit.

How the U.S. Deficit and Debt Are Different

The current U.S. budget deficit is projected to be $503 billion for FY 2017.

That's much lower than the record high of $1.4 trillion reached in FY 2009. For more, see Deficit by President.

The U.S. debt exceeded $19 trillion on January 29, 2016. That's triple the debt in 2000, which was $6 trillion. For more, see Debt by Year.

How Does the Deficit Affect the Debt?

The Treasury must sell Treasury bonds to raise the money to cover the deficit. This is known as the public debt, since these bonds are sold to the public.

In addition to the public debt, there is the money that the government loans to itself each year. This money is in the form of Government Account Securities, and it comes primarily from the Social Security Trust Fund.  As the Baby Boomers retire, they will draw down more Social Security funds than are replaced with payroll taxes. These benefits will be paid out of the general fund. This means that either other programs must be cut, taxes must be raised, or benefits must be lowered.

Unfortunately, legislators have not agreed on an effective plan to meet Social Security obligations.

How Does the National Debt Affect the Deficit?

The debt affects the deficit in three ways. First, the debt gives a better indication of the true deficit each year. You can more accurately gauge the deficit by comparing each year's debt to last year's debt.

That's because the deficit, as reported in each year's federal budget, does not include all of the amount owed to the Social Security Trust Fund. That amount is called off-budget.(Source: St. Louis Federal Reserve, Deficit, Debts and Trust Funds, August 2006)

Second, the interest on the debt is added to the deficit each year. About 5% of the budget goes toward debt interest payments. Interest on the debt hit a record in FY 2011, reaching $454 billion. That beat its prior record of $451 billion in FY 2008 -- despite lower interest rates. By the FY 2013 budget, the interest payment dropped to $248 billion, as interest rates fell to a 200-year low. However, as the economy improved, interest rates rose starting in May 2013. As a result, interest on the debt is projected to quadruple to $850 billion by FY 2021, making it the fourth largest budget item. See Budget Spending

Third, the debt decreases tax revenue in the long run. That further increases the deficit. As the debt continues to grow, creditors can become concerned about how the U.S.

government plans to repay it. Over time, these creditors will expect higher interest payments to provide a greater return for their increased perceived risk. Higher interest costs dampen economic growth. 

How Do They Affect the Economy?

Initially, deficit spending and the resultant debt boosts economic growth. This is especially true in a recession. That's because deficit spending pumps liquidity into the economy. Whether the money goes to jet fighters, bridges or education, it ramps up production and creates jobs.

However, not every dollar creates the same number of jobs. In fact, military spending creates 8,555 jobs for every billion dollars spent. This is less than half the jobs created by that same billion spent on construction. For more, see Unemployment Solutions.

In the long run, the resultant debt is very damaging to the economy, and not only because of higher interest rates. The U.S. government may be tempted to let the value of the dollar fall so that the debt repayment will be in cheaper dollars, and less expensive. As this happens, foreign governments and investors will be less willing to buy Treasury bonds, forcing interest rates even higher.

The greatest danger comes from the debt to Social Security. As this debt comes due when Baby Boomers retire, funds will need to found to pay them. Not only could taxes be raised, which would slow the economy, but the loan from the Social Security Trust Fund will stop. More and more of the government's spending will need to be devoted to pay for this mandatory cost. This would provide less stimulation, and could further slow the economy. 

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